Explain the concept of incremental cost pricing with suitable examples.

Incremental cost pricing is a pricing and decision-making method in which a firm judges a whole decision by the change in total cost and total revenue it produces, rather than by the cost of a single extra unit, considering only the out-of-pocket (variable) costs it actually causes.

1. Meaning: incremental cost is the change in total cost arising from a complete business decision (such as taking a new order or running an extra service), not the cost of one more unit as in marginal cost.
2. Focus on out-of-pocket cost: it counts only the variable, out-of-pocket costs that the decision actually adds, and excludes fixed costs, so it is essentially a short-term method.
3. Irrelevance of fixed cost: fixed overheads are incurred whether or not the decision is taken, so they are treated as irrelevant to the choice.
4. Guiding principle: a decision is sound if it raises revenue by more than it raises cost, or cuts cost by more than it cuts revenue.
5. Accept rule 1: if a decision raises revenue more than cost, undertake it.
6. Accept rule 2: if it cuts cost more than revenue, undertake it.
7. Reject rule 1: if it raises cost more than revenue, do not undertake it.
8. Reject rule 2: if it cuts revenue more than cost, do not undertake it.
9. Worked example: to decide whether Buddha Air should run an extra Kathmandu–Pokhara flight where the fully allocated cost is Rs. 100,000, the out-of-pocket cost is Rs. 60,000 and revenue is Rs. 80,000 — the Rs. 40,000 overhead is incurred anyway (irrelevant), so only the out-of-pocket cost matters: revenue (80,000) − out-of-pocket (60,000) = Rs. 20,000 net gain, so the flight should run.
10. Another example: a firm deciding whether to accept a special bulk order at a reduced price should accept it if the price covers the extra (incremental) variable cost of that order and adds something toward profit, even if it does not cover a share of fixed overhead.

Thus, incremental cost pricing bases decisions on the extra revenue and extra out-of-pocket cost of a whole choice, accepting any decision that adds more to revenue than to cost.